Carillion’s missing millions

Grace Blakeley investigates the curious case of Carillion: how the company’s slow decline and abrupt liquidation reveals the nature of modern capitalism.

Many have argued that the Carillion saga captures everything that is wrong with our economic model. The short-termism and greed that underlie the ideology of shareholder value, the concentration of market power within a small cadre of financialised firms, and the symbiosis between these firms and the state are all hallmarks of what some observers have termed ‘neoliberalism’.

But the particularities of the Carillion case are even more revealing than this story suggests. In fact, the saga of the company’s slow decline and abrupt liquidation reveal a great deal about the nature of modern capitalism.

The Emperor’s Clothes

Carillion made almost £150m worth of pre-tax profit last year on around £5bn worth of revenue. Despite a fall in profits on last year, the full year dividend on Carillion’s shares was increased from 18.25p to 18.45p. In fact, the yield on Carillion shares has remained at around 8.5% over the last few years, next to a FTSE100 average of 3.5%.

Its Chief Executive, Richard Howson, made £660,000 last year, on top of a £245,000 bonus. Including pensions, benefits, and other ‘incentives’, his total remuneration stood at £1.5m. The outgoing finance director, who jumped ship just after Carillion issued its profits warning earlier this year, made £460,000, received a bonus of £140,000, and had a total pay package of around £1m.

These extensive payouts belied the parlous state of Carillion’s underlying financials. Over the last 10 years Carillion’s profits have continuously declined whilst its debt levels have skyrocketed. A firm should only ever take on debt for the purposes of investment; debt financing comes with interest, which has to be paid off regardless of the firm’s performance — so unless the capital is used to improve the firm’s profitability it will end up as an unpayable debt overhang.

But Carillion issued this debt just to meet its day-to-day running costs. Having taken on a number of contracts that it was unable to deliver profitably, the firm covered the difference with debt. Interest payments came to eat up an increasing share of profits — in 2016, the firm forked out £57m in interest payments and bank expenses alone. As Carillion’s debt burden mounted, it had to take on even more contracts just to meet its debt servicing costs.

Recent documents reveal that the firm was left with just £29m in cash when it collapsed. It owed £1.29bn to the banks. As the Government is left to pick up the pieces of Carillion’s undelivered contracts, these banks will be carving up Carillion to claw back every penny.

Carillion’s directors had effectively constructed a giant Ponzi scheme, throwing good money after bad until the firm eventually collapsed under the weight of their profligacy. The rewards that they received for their mismanagement reflected nothing but the extensive power they were able to wield over a firm that had effectively become their personal fiefdom.

Nationalising Nothing

Some might argue that this can all be chalked up to financial mismanagement on the part of a few greedy executives. After all, a huge business like Carillion must have been producing something of value before its unceremonious decline. All we need to do is nationalise the business, so that that this value accrues to the public sector rather than private shareholders.

In fact, the opposite is true. Carillion’s business model rests primarily on arbitrage — ‘the simultaneous purchase and sale of an asset to profit from a difference in the price’. We cannot nationalise Carillion because there is nothing in Carillion to nationalise. The company merely uses its expertise in bidding for Government contracts to intermediate between a Government that lacks the desire or capacity to do proper public procurement and the suppliers that end up doing the work.

One observer in the Financial Times has picked up on this issue. In a recent article, Matthew Vincent wonders why Carillion went immediately into liquidation rather than administration. A company in administration can continue to operate whilst shedding nonviable parts of its business, but a liquidated company ceases trading and is immediately carved up to pay back creditors.

As Vincent puts it:

‘Carillion’s “compulsory liquidation” proves it had already reached a point where there was nothing worth buying. All it had was its contracts, on which the margins were evidently too low to cover its ever growing liabilities. There was no viable business to sell. There were no meaningful assets.’

Towards a New Model

Nationalising Carillion will leave the public sector with nothing more than a very expensive Ponzi scheme. What is really needed is a fundamental rethink of public procurement in this country.

Firstly, public contracts should not be awarded solely on the basis of ‘value for money’. The idea that the Government’s sole purpose is to operate as cheaply as possible is a bizarre product of the ‘new public management’ ideology that came to dominate thinking in the public sector during the 1990s. Government contracts should be about creating value for the public — where value is understood in holistic rather than narrow economistic terms. The quantity and quality of employment created by a supplier, the nature of its corporate governance, its levels of executive remuneration, its environmental impact, its attitude towards tax — all of these things and more should be accounted for when determining who wins a Government contract.

Secondly, the oligopolistic nature of competition for Government contracts must be dealt with. Rather than granting contracts to a cabal of huge multinationals who then commission real firms to do the work, the Government should get rid of the middle man and deal with suppliers directly. The current model makes no sense unless its purpose is to enrich executives and shareholders like Richard Howson. These firms should not be nationalised — they should be denied the ability to exist.

Thirdly, both of these things will require investment in public sector procurement capacity. Currently, the Government commissions consultancy firms to write contracts on its behalf, and these consultancies are then hired by outsourcing firms to assist them in winning these very contracts. Instead, the Government should invest in its own procurement systems, upskilling staff and providing them with the right resources to subvert the arcane processes that currently dominate bidding for public contracts.

Fourthly, and alongside a broader socialisation of company ownership in this country, these suppliers should be part owned by the public sector. The Government could take a stake in any company that bids for a Government contract by buying up a portion of its equities (or having them issue new ones) and holding these in a sovereign wealth fund. This would ensure that a portion of the profits derived from Government-sponsored activities would be returned to the taxpayer.

In the wake of Carillion’s collapse, the contradictions at the heart of its business model are acutely visible. But the Carillion scandal will only be in the headlines for a few days. Meanwhile, as its assets are sold off to pay back its investors, the economic model that created Carillion will continue to tick along. The Government won’t do it, the mainstream media won’t do it, and the private sector certainly won’t do it — it’s up to the left to learn the right lessons from this saga, and make sure it doesn’t happen again.